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Navigating the risks and opportunities inemerging markets

By Harry Broadman

Harry Broadman is Chief Economist and Leader of PwCs Emerging Markets practice.

One question increasingly on the mind of a lot of corporate senior executives today is: What are the risk/opportunity

tradeoffs of investing in emerging markets? Of course, emerging markets a term that typically refers to all

developing countriesare not a monolith. They are a very heterogeneous group. But the fact is that, as a whole, the

rate of growth in emerging markets for the past decade and a half has been twice that of advanced countries, and

this trend is unlikely to abate anytime soon. This is why there is increasing interest in emerging markets by

companies in advanced economies, where growth has been much slower. Importantly, these growth differentials

reflect a secular transformation in the structure of the global economy, not a cyclical phenomenon occasioned by

the current economic/financial crisis. This is a critical distinction that too few corporate executives appreciate.

Understanding the challenges and rewards

There are, however, significant misperceptions about the challenges and rewards of doing business in emerging

markets. In many cases, the risks are either highly understated or grossly overstated. The same is true with

opportunities. Take China, for example. Many executives of large companies believe they should and cando

business there.1From my experience having worked for two decades in China, the investment environment there is

far more nuanced and complex than most investors appreciate. In my view, its a classic case of a place where the

on-the-ground investment risks generally are understated. At the other extreme, consider Africa. Most corporate

managers whom I talk to in developed countries lack accurate information about market conditions on the African

continent. They dont know that about one -half of the population in sub-Saharan Africa lives in countries where GDP

growth, adjusted for inflation, has averaged more than 5 percent per year over the last two decades, or they dont

know that there is a burgeoning African middle class (and Im not referring to South Africa alone, by any means).

Indeed, a large number believe there simply arent any realistic investment opportunities in Africa. At the same time,

people see African markets as fraught with excessive risk. There are, of course, appreciable risks of investing inAfricajust as there are substantial risks of investing in Latin America, Asia, the Middle East, the former Soviet

Union, and so on. But the perceived risks in Africa are grossly overstated. In fact, according to recent data from the

United Nations Conference on Trade and Development, Africa offers the highest risk-adjusted returns on foreign

investment among all emerging economies.

Its not just advanced country CEOs who are pondering investment in emerging markets. Powerhouse

multinationals out of Brazil, China, India, and South Africaamong othersare themselves competing across their

own geographies. At the same time, such firms are becoming bona fide contenders for market share in developed

markets (North). Indeed, not only are the traditional trade and investment flows continuing between developed and

developing economies, but there is tremendous growth in commerce among emerging markets (South-South).

South-South trade now accounts for a sizable 20 percent of all global trade, and one-third of foreign direct

investment outward flows originating from the South go to the South.

Implications for strategy and operations

What does this transformation mean for business strategy and operations of advanced country multinationals?

Theyre confronting a host of new risks and opportunities as they aim to compete not only with their longtime rivals

from developed countries but also with world-class emerging market firms. Consider the athletic footwear industry.

Most of the major athletic footwear firms are headquartered in the North but produce a majority of their output in the

South, especially in China. And, as it happens, a sizable portion of Chinese production in this sector is exported to

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Brazil. The result is that Brazilian athletic footwear manufacturers feel they cannot effectively compete against the

Chineseso much so that Brazil believes these products are being dumped at an artificially low cost into the

Brazilian market. Consequently, Brazils government placed a duty on imported Chinese athletic footwear. This

ensuing trade war among the governments of two large emerging markets has sideswiped the worlds major

branded athletic footwear companies, cutting their sales revenues and leaving these companies with li ttle recourse

for remedies in the short run.

In light of all this, how do Northern multinationals move forward to exploit the new opportunities arising in the fast-

growing emerging markets while mitigating the risks? The first critical step is to ensure you know your customers,

your partners, the particular government with which youre dealing, and other stakeholders. The best way to do this

is to carry out tailored due diligence, employing different types of lenses and techniques and especially by using

independent, verifiable sources.

To be sure, carrying out world-class due diligence can be more difficult in emerging markets since, by definition,

their institutions are nascent and their information frameworks less developed. I frequently see companies rely on

self-proclaimed experts in the local economies, only to discover that these people themselves are not the best

people to have relied upon. The ability to perform world-class due diligence comes from having done it repeatedly

throughout challenging parts of the world so there is the capacity to recognize similar problems when they crop up,

and the information is collected and interpreted by parties who are independent to the transaction and are mutually

trusted by all sides.

Such due diligence can be applied in a number of ways by foreign investors to effectively mitigate risks and

maximize opportunities. One approach is to establish business-to-business (B2B) alliances. For example, a

multinational electric power company might establish a B2B agreement with an oil company in Vietnam because

thats a high-risk, high-return market. If the B2B performs well, the two companies could replicate the relationship

elsewhere in Southeast Asia or in another region.

Business-to-government agreements or public-private partnerships are another avenue. A multinational engineering

and construction company recently signed a 15-year master service agreement with the government of Gabon to

become an anchor investor and provide management and technical support to the government as it develops a

national infrastructure master plan. Similarly, a major beverage multinational has formed a partnership with a largeprivate foundation, three African governments, and a project management entity that provides for local fruit farmers

to sell juice to the beverages supply chain, substituting for juice imports. Win -win solutions like these expand the

bottom line and also fulfill legitimate objectives on the part of a government to spur growth and create jobs.

For more ways corporations can manage risk while exploiting opportunities, see the graphic below.

This list, of course, is not exhaustive. But it illustrates the type of tactics that, if adopted, can significantly reduce a

firms exposure to risks.

Adapting to change

The industrial landscape of the world market has changed unalterably. But this is just the beginning. There will bemultiple growth nodes from here on out and not just between the advanced countries and the emerging markets

but within emerging markets. The effect on companies from the developed world will continue to be profound.

Adopting an investment strategy informed by accurate information and trusted partners with deep local insights and

experience is the best way to navigate the risk-opportunity tightrope. But the biggest risk in emerging markets could

be just ignoring them.